As a non-spouse beneficiary to my deceased mothers traditional IRA, Can I have another banking institution transfer the original IRA into their institution and reopen the new account as trustee-to-trustee and continue to take the necessary RMD's with the new institution that has a much higher paying interest rate?
-Regina, Georgia
Dear Regina,
I am sending my condolences to you on the passing of your mother. The loss of a parent is an emotional time, even under the best circumstances. With all the decisions that need to be made and loose ends to tie that come with the passing of a loved one, gathering as much information as possible goes far in making wise financial choices.
When someone other than a spouse, like a child, friend, etc., inherits an IRA from a person that has passed, the IRA is considered an inherited IRA. The rules surrounding a traditional IRA inherited by a non-spouse beneficiary are stricter than the rules when a surviving spouse acquires an IRA. For instance, when a surviving spouse obtains a traditional IRA from their deceased spouse, they may elect to treat the IRA as their own. They can roll the acquired IRA over into their own IRA account and make contributions to the account afterward. A non-spouse beneficiary of a traditional IRA does not have these options.
Nonetheless, a non-spouse beneficiary can instruct the investment company that holds the inherited IRA to directly transfer the account to another financial institution chosen by the person inheriting the IRA. This type of transaction is known as a trustee-to-trustee transfer. During a trustee-to-trustee transfer, the account funds do not touch the hands of the owner or beneficiary. It is essential that the account is moved via a trustee-to-trustee transfer. The transfer is considered a taxable distribution if the account is moved by any other method. The new account must be opened as an “inherited IRA” to be considered a qualified transfer. Additionally, the new account must remain in the deceased individual’s name. Transferring the inherited IRA to a financial institution of the beneficiary’s choosing allows them some control over how the funds are invested. Here is an example.
After a life well lived, Martha Jones took her last breath on Earth at the age of 95. Martha’s husband had passed over ten years ago. During their 50-year marriage, they had one daughter named Ella. Along with the family home and various investments, Ella inherited what remained of her mother’s traditional IRA. Martha was concerned about her traditional IRA losing value, so she invested the funds into a money market account that earned about 1.5% interest. Being more risk-tolerant, Ella wanted to invest the traditional IRA she inherited from her mother into a couple of different mutual funds. Already having a traditional IRA and Roth IRA under an advisor’s management, Ella wanted to move the inherited IRA to her advisor’s financial institution.
Ella contacted the financial institution that managed her mother’s IRA and requested they move the account to her advisor’s financial institution via a trustee-to-trustee transfer. Ella instructed her financial advisor that the transferred account is a traditional IRA she inherited from her mother. Because it is an inherited IRA, Ella’s advisor did not deposit the funds into her traditional IRA account. Her advisor transferred the funds from the inherited IRA into a new account and titled it “Martha Jones, IRA, FOB Ella Raines.” (“FOB” is an abbreviation meaning “for the benefit of.”) As this is an inherited IRA, Ella will not be depositing any of her yearly IRA contributions into it.
You may have heard of an “indirect rollover” and the “60-day rule.” An indirect rollover is when a taxpayer takes all or a part of their retirement account (for example, their IRA) and physically moves the funds to another account or financial institution, rather than having the financial institution transfer the funds.
Due to the rules surrounding an inherited IRA, indirect rollovers are not permitted. If a taxpayer does an indirect rollover with an inherited IRA, the transaction will be considered a taxable distribution, and all of the money taken out will be taxable in the year it was distributed. This is true even if the taxpayer tries to redeposit the money into the same or another retirement account.
The Setting Every Community Up for Retirement Enhancement (SECURE) Act of 2019 made considerable changes to the required minimum distribution rules for non-spouse beneficiaries of inherited IRAs. Non-spouse beneficiaries who inherit an IRA from someone who passes away after December 31, 2019, must distribute the entire balance in the inherited IRA account within 10 years. In the year of the 10th anniversary of the original IRA owner’s passing, the beneficiary has until December 31st to withdraw all the funds in the account. As the law currently states, non-spouse beneficiaries do not have to take required minimum distributions every year leading up to the 10-year anniversary of the original IRA owner’s death. As I previously mentioned, the new 10-year distribution rule does not apply to spousal beneficiaries. Additionally, the new rule does not apply to other beneficiaries, including:
- Minor children of the deceased IRA owner
- A beneficiary that is disabled or chronically ill
- A beneficiary who is not more than 10 years younger than the deceased IRA owner
To help understand the new rule, let’s review the prior example. If Martha died on June 15, 2021, Ella would have until December 31, 2031, to distribute the total balance within the inherited IRA account. Ella could choose to not take any distributions until the 10th year or decide to take distributions yearly. Although the new rule shortens the time a non-spouse beneficiary has to take distributions from an inherited IRA, the beneficiary can still do some careful tax planning to help minimize the taxes paid on the distributions. For example, Ella owns a rental property that she wants to sell. Due to unforeseen circumstances, Ella was unable to keep the rental property in good repair and knows she will sustain a substantial loss when it is sold. Ella sells the property in 2027 and has a $75,000 loss on her return. If Ella decides to take a large distribution from the inherited IRA in 2027, the loss on the rental property will help offset the tax on the inherited IRA distribution.
If any funds remain in the account on January 1, 2031, Ella would be subject to a 50% penalty for failure to withdraw the required distribution when she files her 2031 return. The 50% penalty tax will apply every year until all the funds are distributed and the account is closed. This is a hefty penalty that most want to take great care in avoiding. If the beneficiary can show reasonable cause why the entire balance was not distributed timely, the IRS may waive the penalty. The required minimum distribution rules on IRA accounts where the owner died before January 1, 2020, are a bit more complicated and are dependent on whether the original IRA owner had already reached the age where they were required to take distributions. If your mother passed before January 1, 2020, I recommend discussing the required minimum distribution rules with a tax professional.
Wishing you financial prosperity and many happy returns,
Jean Lee Scherkey, EA